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5 unintended consequences of Australia's gas market intervention

1 minute read

On 1 July 2017, the Australian government implemented its gas export restrictions policy, the Australian Domestic Gas Security Mechanism (ADGSM), to try to alleviate public and industry concerns regarding gas supply availability.

This intervention into the market presents a number of potential unintended consequences for Australia:

1. Creating uncertainty, when certainty is needed most

Large discretion is left to the resources minister, with little guidance to how key elements of the policy will operate. Much remains unclear:
• how will a domestic shortfall be determined?
• how will the minister factor price into his decision-making?
• what is the relevant price benchmark and where along the value chain price is it measured?
• from which baseline will exports be restricted?
• is the policy aimed at increasing gas availability or lowering prices?
• how much certainty can be given to AEMO supply forecasts? (Indeed AEMO has recently made material revisions to its forecasts within the space of a few months)

This throws an additional layer of policy uncertainty on top of the existing policy uncertainty in the energy market, which the government's recent Finkel review has acknowledged led to the energy security crisis we face today, discouraging investment in the sector. Both gas producers and buyers will feel little comfort from the ADGSM and could be more hesitant to make long-term contractual and investment decisions under its framework.

2. Queenslanders and tax revenue take a hit

The overall efficacy of the ADGSM will depend on how the government takes price into consideration when making its determinations. At a high enough price, gas buyers will be flooded in gas. The question remains: if gas is offered for sale in Queensland at a LNG-linked price and no buyers take it up, is there still a shortfall? Ultimately, the government has to make a call on what it considers to be the 'right price' for domestic gas buyers.

Queensland CSG drilling is ongoing and price sensitive. If the government seeks to achieve lower domestic gas prices than LNG netbacks in Queensland, this will lead to lower revenue and production than would have occurred otherwise, and therefore lower taxes and Queensland royalties. So the net result would be Queenslanders taking a hit to their public services to partly subsidise industry in the southern states.

3. Sets a precedent putting Australia's future gas security at risk

Calls for government intervention from gas buyers are set to continue for years to come. The ADGSM sets a concerning precedent that risks regulatory creep towards greater price intervention, as there is little line of sight to how the situation will be materially different when the policy comes up for review in 2020.

The gas market remains tight in the short term, but concerns over gas supply shortages become acute post-2020. Domestic gas supply is set to halve from current levels over the next decade if new supply isn't brought onstream. There is still time to invest in new exploration and development to alleviate this situation by early next decade. But a supply-side response to the new price signal we are seeing, through additional exploration and development investment, will be hindered if the Damocles sword of further government intervention remains ever present.

4. Raising Australia's above-ground risk profile

The loud, populist rhetoric displayed over the past six months has raised alarms regarding Australia's investment stability for foreign investors. The ADGSM intervention puts long-term LNG sales contracts at risk, which are the bedrock of the LNG industry, having underpinned over US$230 billion of investment in Australia over the past decade. Australia, despite being a higher cost place to invest, has received a major proportion of global LNG investment, in large part because of its hard-earned reputation for investment stability. But reputations earned over decades can be easily lost. Australia's investment reputation is now being seriously brought into question internationally, which could jeopardise future investment, not only in Australia's gas sector but more broadly.

5. It wont work: unlikely to increase domestic gas supply

Up to 25% of GLNG's forecast LNG production could be restricted through to 2020 in the event a 'shortfall' is declared. But there is no obligation to deliver that gas to the domestic market. GLNG has the option of turning down wells, putting gas into storage and drilling less of its marginal wells, keeping at least some of that gas in the ground. Drilling of some marginal wells may only be viable if gas can be delivered into existing GLNG export contracts. The ADGSM also doesn't address internal GLNG joint venture alignment obstacles to gas diversions. The spectre of the ADGSM reducing exports, but seeing some of that gas stay in the ground rather than sent to the domestic market, is real.

We expect any gas shortage over the next few years would be made up for by increased supply, particularly diversions from QCLNG and APLNG, in response to price signals, without any government intervention. Any gas molecule GLNG does end up diverting to the domestic market will simply be one less gas molecule that Shell or APLNG contract domestically, leaving overall domestic supply unchanged. There is also scope for gas trades to occur between GLNG and the neighbouring LNG projects, reducing GLNG exposure to export restrictions. This would result in an overall inefficient arrangement to achieve the same export and domestic gas supply outcome.

The ADGSM could also help see the re-emergence of the risk of blackouts. With a stretched energy and gas supply situation, there remains a risk of power outages when inevitable power or gas supply interruptions occur. The ADGSM, and other policies such as the Peak Supply Guarantee, might encourage electricity generators to become less conservative in their gas procurement and storage planning, instead relying on the government to intervene to make up for unexpected shortfalls. This could increase the likelihood and frequency of short term-gas shortfalls actually occurring.

And when it comes to pricing, a significant part of end-user prices constitutes the transport costs and retail margins to get the gas from Queensland to where it is needed in the southern states. However, this is beyond the control of GLNG — the entity solely targeted by the ADGSM.

The upshot

We expect that a price-driven, supply-side response would have avoided any gas supply shortages. The final policy outcome has now confused concerns over gas availability, with concerns over high gas prices, which has left stakeholders unclear as to what exactly the goal of the policy is. Either way the ADGSM is either going to prove redundant or result in lower gas production and less money for Queenslanders. It does not deal with the core issues affecting supply and prices, including transportation and retail margins, cost of production, and internal joint venture alignment. It presents risks and uncertainty that will make gas supply security worse rather than better, over both the near and long term.

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